Securities and Exchange Commission v. Criterion Wealth Management Insurance Services, Inc.

Case 2:20-cv-01402-ODW-JEM Document 81 Filed 04/25/22 Page 1 of 39 Page ID #:6855

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8 United States District Court

9 Central District of California

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11 SECURITIES AND EXCHANGE Case № 2:20-cv-01402-ODW (JEMx)

COMMISSION,

12 ORDER GRANTING IN PART AND

Plaintiff,

13 DENYING IN PART PLAINTIFF’S

v. MOTION FOR SUMMARY

14 JUDGMENT [41]; ORDER

CRITERION WEALTH MANAGEMENT

15 SERVICES, INC., et al., DENYING DEFENDANTS’

MOTIONS FOR SUMMARY

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Defendants. JUDGMENT [50] [51]

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18 I. INTRODUCTION

19 The Securities and Exchange Commission (“SEC”) brought this enforcement

20 action against Defendant Criterion Wealth Services and its co-owners, Defendants

21 Robert A. Gravette and Mark A. MacArthur, for fraud and breach of fiduciary duty in

22 violation of the Investment Advisers Act of 1940 (“Advisers Act”), 15 U.S.C.

23 §§ 80b-1 to 80b-18c. Three summary judgment motions are pending. First, the SEC

24 moves for summary judgment in its favor as to liability on its first, second, and fourth

25 claims. (Notice SEC Mot., ECF No. 41.) Second, Criterion and Gravette move

26 together for summary judgment in their favor on the SEC’s first, second, and fifth

27 claims. (Criterion Mot., ECF No. 51.) Finally, MacArthur moves for summary

28 judgment in his favor on the SEC’s first, second, and sixth claims. (MacArthur Mot.,

Case 2:20-cv-01402-ODW-JEM Document 81 Filed 04/25/22 Page 2 of 39 Page ID #:6856

1 ECF No. 50.) After carefully considering the papers filed in connection with the

2 Motion, the Court deemed the matter appropriate for decision without oral argument.

3 Fed. R. Civ. P. 78; C.D. Cal. L.R. 7-15. For the reasons that follow, the Court

4 GRANTS IN PART and DENIES IN PART the SEC’s Motion, and the Court

5 DENIES Defendants’ Motions.

6 II. FACTUAL BACKGROUND

7 Criterion is registered as an investment adviser with the SEC, and between 2014

8 and 2018, it managed $58 million to $190 million in investments.1 (Pl.’s Statement of

9 Uncontroverted Facts (“PSUF”) 1, 3, ECF No. 41-2; see also Criterion Resp. PSUF,

10 ECF No. 62-1; MacArthur Resp. PSUF, ECF No. 65-1.) Defendants Gravette and

11 MacArthur are individual investment advisers who co-owned Criterion until 2016, at

12 which time MacArthur converted to working for Criterion as an independent

13 contractor. (PSUF 4–14.) In 2017, MacArthur left Criterion altogether. (PSUF 15.)

14 Throughout most of this period, Gravette and MacArthur were the only investment

15 adviser representatives at Criterion. (MacArthur Statement of Additional

16 Uncontroverted Facts (“MacArthur SAUF”) 262, ECF No. 65-1.)

17 Criterion, as a registered investment adviser, filed annual Form ADVs2 from

18 2014 to 2020, with Gravette signing the Form ADVs for most of this period. (PSUF

19 16–17.) In describing its business, Criterion represented in Part 2 of its Form ADVs3

20 that it provided “advisory services,” including “continuous advice to a client regarding

21 the investment of client funds based on the individual needs of the client” and

22 “portfolio management services . . . using an asset allocation portfolio approach”

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1 Facts supported by citations to any party’s Statement of Uncontroverted Facts or other separate

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statement-type document are undisputed unless otherwise specified. See C.D. Cal. L.R. 56-3

25 (permitting courts to assume as undisputed facts in a separate statement not controverted by

declaration or other written evidence filed in opposition).

26 2 Financial advisers must annually submit to the SEC a Form ADV containing a description of their

business and a disclosure of any conflicts of interest. (Mem. SEC Mot. 1, ECF No. 41-1); Vernazza

27

v. S.E.C., 327 F.3d 851, 856 (9th Cir. 2003).

28 3 Investment advisers are required to provide their investor clients with disclosure statements

comprising the same information found in Part 2 of the Form ADV. Vernazza, 327 F.3d at 856.

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1 based on “a personalized variation of a model asset allocation portfolio which is

2 designed to meet a particular investment goal.” (PSUF 18.) Criterion further

3 represented that its “investment recommendations . . . will generally include advice

4 regarding the following securities,” followed by a list of twenty-one types of assets

5 Criterion might recommend. (PSUF 19.) One of these asset types was “Private

6 Placement Offerings.”4 (Id.)

7 The majority of Criterion’s clients were individual investors. (PSUF 24.)

8 Criterion formalized its advisory relationships by having new clients sign an

9 Investment Advisory Agreement. (PSUF 25.) This Advisory Agreement provided

10 that Criterion, in its capacity as a registered investment adviser, would provide either

11 or both of the following types of investment services: (1) Discretionary Investment

12 Management Services, which were based on “an evaluation of clients[’] goals,

13 investment objectives, needs, financial and tax status, investment policies, guidelines,

14 reasonable restrictions and risk tolerance among other factors;” and (2) Alternative

15 Investment Consulting, which would “allow access to an alternative investment on a

16 stand alone basis to accredited investors only.” (PSUF 26–28.) Criterion charged

17 fees for its advisory services in the form of a percentage of an investor’s assets under

18 management with Criterion. (PSUF 20.) Until 2016, Criterion had two different fee

19 schedules. The first was a higher percentage-of-assets fee applied to services

20 encompassing stocks, bonds, and cash. (PSUF 21.) The second was a lower

21 percentage-of-assets fee, the “Alternative Investment Fee,” applied to services

22 encompassing hedge fund investments, private placement investments, and private

23 equity investments.5 (PSUF 22.)

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26 4 “Private Placement Offerings” refer to securities sold through a private offering to a small group of

investors. Private placements are offered to a limited pool of accredited investors and are not

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offered to the public.

28 5 In either 2016 or 2017, Criterion stopped offering its Alternative Investment Consulting (i.e.,

lower) fee schedule. (PSUF 35.)

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1 The Advisory Agreement referred to Criterion’s Form ADV and required

2 clients to sign with their initials to indicate receipt of the Form ADV. (PSUF 36.)

3 Gravette and MacArthur each signed the Advisory Agreements as a “Financial

4 Advisor.” (PSUF 37.)

5 In addition to their positions with Criterion, Gravette and MacArthur were also

6 registered representatives of Ausdal Financial Partners, Inc. (PSUF 48, 51.) Ausdal is

7 a registered broker-dealer. (PSUF 49.) Gravette and MacArthur operated Ausdal in

8 concert with their operation of Criterion; specifically, when investors entered into a

9 relationship with Criterion, those investors opened a brokerage account with Ausdal to

10 invest in private securities. (Criterion’s Statement of Uncontested Facts (“Criterion

11 SUF”) 12, ECF No. 51-1.) Ausdal, acting through Gravette and MacArthur, would

12 then broker the transactions in the private placement investments for Criterion’s

13 clients. (PSUF 56.) This practice began as early as June 2014, with Ausdal brokering

14 the private placement investments for Criterion’s clients. (PSUF 61.) The majority

15 of Ausdal’s broker-dealer clients were also Criterion’s advisory clients. (PSUF 55.)

16 Each investor who was to invest in private placements would complete and sign

17 an Ausdal New Account Form. (Criterion SUF 10.) Moreover, before an investor

18 made a particular investment in a private placement, the investor completed and

19 signed an Ausdal Private Placement Information Form. (Criterion SUF 11.) The

20 investor would also receive copies of the fund’s offering documents, including the

21 private placement memorandum. (Criterion SUF 12.)

22 With respect to these investments, Gravette and MacArthur would conduct due

23 diligence, employ the above-mentioned “asset allocation portfolio approach,” and

24 perform continuing due diligence after the investments were made. (PSUF 41–44.)

25 At regular intervals, Criterion offered its clients broader portfolio reports that

26 integrated information about all of a given client’s assets under management—

27 including stocks, bonds, private placement offerings, and all other holdings—into a

28 single digest. (PSUF 45.)

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1 Defendants do not dispute this basic business structure; instead, they dispute in

2 which capacity—investment adviser or broker-dealer—Gravette and MacArthur acted

3 when recommending private placements, executing the transactions, and monitoring

4 the investments on behalf of their dual Criterion/Ausdal clients. (See PSUF 61.)

5 A. T2’s Funds: SREI and AOFIV

6 Four private placement offerings are at issue in this case. Two were offered by

7 T2 Holdings, LLC, a company with whose two principals MacArthur had a pre-

8 existing personal and professional relationship. (PSUF 92.) The first T2 fund is the

9 Strategic Real Estate Income Fund (“SREI Fund”). (PSUF 88.) Initially, T2 made

10 investments in the SREI Fund available to investors solely through Class A units.

11 (PSUF 89.) Returns on Class A units came in three phases. First, Class A unitholders

12 in the SREI Fund would receive all returns until profits achieved a 6% annualized

13 return threshold (i.e., a 6% “hurdle”). Then, T2 was entitled to a performance

14 allocation of 100% of all new investment income until its profit participation had

15 caught up such that 80% of all profits to date had been allocated to Class A investors,

16 and 20% had been allocated to T2. Third and finally, for any investment returns after

17 that, Class A investors and T2 shared in investment income at 80% and 20%,

18 respectively. (PSUF 90; Compl. ¶ 38, ECF No. 1.) In short, this was “an 80/20 profit

19 split in favor of investors with a 6% hurdle.” (Compl. ¶ 39.)

20 Ausdal entered into a placement agreement with T2 under which Ausdal would

21 broker investor transactions in the SREI Fund, and in exchange, T2 would pay Ausdal

22 50% of the performance allocation that T2 received for as long as the investors Ausdal

23 referred remained invested in the SREI Fund. (PSUF 95.) As part of this placement

24 agreement, T2 created special Class C units for the SREI Fund, available only to

25 Criterion clients. Class C units were identical to Class A units, except that after the

26 investment cleared the hurdle, Class A investors and T2 would share income at 60%

27 and 40%, respectively (rather than at 80% and 20%). In short, Class C units provided

28 a 60/40 profit split in favor of investors with a 6% hurdle. (PSUF 103; see Compl.

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1 ¶ 42.) Criterion’s clients who invested in the SREI Fund purchased only Class C

2 units. (PSUF 106.) All other investors in the SREI Fund, who were referred to it by

3 at least twenty other investment advisers, invested in Class A units. (PSUF 105, 107.)

4 T2 had a separate fund called the T2 Opportunity Fund IV (Master), L.P.

5 (“Master Fund”), which it launched in 2014 with a single feeder fund. (PSUF 123.)

6 The shares offered by that feeder provided an 80/20 profit split in favor of investors

7 with an 8% hurdle. (PSUF 127.) To accommodate Criterion and Ausdal, T2 created a

8 second feeder fund called T2 Asset Opportunity Fund IV (“AOFIV”). (PSUF 125–

9 126.) Ausdal entered into a placement agreement with AOFIV under which Ausdal

10 would broker investor transactions with AOFIV, and in exchange, T2 would pay

11 Ausdal 50% of the allocation that T2 received from the Criterion funds in AOFIV for

12 as long as the investors Ausdal referred remained invested in AOFIV. (PSUF 135.)

13 Shares in AOFIV provided a 60/40 profit split in favor of investors with an 8% hurdle.

14 (PSUF 129.) Thus, as with the SREI Fund’s Class A and Class C shares, the main

15 material difference between the first feeder fund and AOFIV was in the third phase of

16 the distribution formula, which provided a less favorable profit split for Criterion

17 investors than for other investors. (PSUF 132.) The effect of this difference, simply

18 stated, is that the worse the SREI Fund or AOFIV performed, the better the returns for

19 Criterion investors in relation to other investors; and conversely, the better the funds

20 performed, the worse the returns for Criterion investors in relation to other investors.

21 (PSUF 133.)

22 AOFIV’s private placement memorandum contained a chart describing the

23 internal rate of return for T2’s vintage real estate funds as between 12% and 15%, well

24 clear of the 8% hurdle. (PSUF 130.) The SREI Fund materials apparently did not

25 contain such data, but both Gravette and MacArthur testified that, at the time they

26 invested client funds in the SREI Fund, they expected the return on the investment to

27 exceed the SREI Fund’s 6% hurdle. (Decl. Michael Sew Hoy (“Sew Hoy Decl.”) Ex.

28 3 (“Gravette Dep.”) 110:4-6, ECF No. 42-3; Sew Hoy Decl. Ex. 4 (“MacArthur

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1 Test.”) 159:16-20 (“[T]his was . . . going to be a 7 to 9 percent total return product.”).)

2 That the SREI Fund and AOFIV were expected to clear their hurdles corresponds to

3 the T2 Chief Executive Officer’s expectation that investor returns on AOFIV would

4 be approximately 2% lower than returns on the first feeder to the Master Fund.

5 (PSUF 151.) Indeed, the respective financial statements for the two feeder funds

6 show lower reported returns for AOFIV than for the first feeder. (PSUF 152.)

7 As discussed above, each private placement transaction in the SREI Fund and

8 AOFIV brokered by Ausdal generated commission fees paid to Ausdal. The exact

9 fees paid to Ausdal depended upon T2’s performance allocation, which in turn

10 depended on the interplay of the hurdle, catch-up, and profit-sharing provisions

11 associated with each fund. But for the purpose of this analysis, it suffices to observe

12 that the commission fees paid to Ausdal were calculated as some percentage of the

13 Criterion investors’ funds that were invested in placements brokered by Ausdal. In

14 turn, Gravette and MacArthur took 95% of these commissions for themselves by first

15 accounting for the Ausdal commissions as income for Criterion and then taking

16 distributions from Criterion as Criterion’s co-owners. (PSUF 62–72.)

17 Commissions from Ausdal represented about half of Defendants’ income

18 between 2014 and 2017. (PSUF 71.) At the same time Gravette and MacArthur

19 collected these broker commissions from Ausdal, Criterion continued to collect its

20 alternative investment fees from its clients invested in the SREI Fund and AOFIV, as

21 a percentage of the then-current value of the alternative investment under management

22 by Criterion. (PSUF 122, 149.)

23 Gravette and MacArthur, in their capacities as representatives of Criterion, did

24 not disclose to their clients the nature or the amount of the commissions they were

25 taking on the private placement transactions that Ausdal brokered. (PSUF 63.)

26 Furthermore, they did not disclose to their Criterion/Ausdal clients that SREI Class A

27 shares were available to investors through other channels. (PSUF 113–114.) And

28 although they did disclose, in their capacities as representatives of Ausdal, that Ausdal

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1 was the selling agent and would therefore be receiving fees from brokering the private

2 placement transactions, they did not disclose that they as individuals would ultimately

3 receive 95% of the fees paid to Ausdal. (PSUF 116, 118, 143, 145.)

4 The parties do not dispute these basic facts regarding the SREI Fund and its two

5 classes of shares, and the AOFIV and its two feeder funds. The SEC asserts that

6 “Defendants’ compensation arrangement with T2 diluted the returns of Criterion

7 clients who invested in SREI by adding an extra layer of fees to the distribution

8 waterfall.” (PSUF 121.) Defendants disagree, pointing out that “the performance

9 allocation would not come into play if the Fund met or fell short of the hurdle; in that

10 case – or even if the Fund exceeded the hurdle slightly – Class A investors would earn

11 lower returns because they invested through [other] investment advisers . . . .” (Id.;

12 see also MacArthur SAUF 295 (asserting this compensation arrangement benefitted

13 investors by (1) “reduc[ing] the Investors’ downside risk by eliminating or reducing

14 either a recurring investment advisory fee or an up-front commission,” and

15 (2) “align[ing] MacArthur’s interests with those of [his clients] by requiring that the

16 Investors receive a certain return before MacArthur received any commissions”).

17 Defendants assert that they properly disclosed all relevant details of their business

18 structure to their Criterion/Ausdal clients, including all relevant conflicts of interest,

19 and that they therefore did not breach any duty of any type to their clients. The SEC

20 disagrees and maintains that Defendants violated the Advisers Act by providing only

21 partial or incomplete disclosures.

22 B. Bird Rock’s Funds: Southland Home Mortgage II Fund and Pacific West

23 Home Mortgage II Fund

24 Two more funds are at issue in this case: the Southland Home Mortgage II Fund

25 and the Pacific West Home Mortgage II Fund, launched by Bird Rock Ventures in

26 2015 and 2016, respectively. (PSUF 172.) Gravette and MacArthur had a pre-

27 existing relationship with Bird Rock’s principals through college- and church-related

28 connections. (PSUF 163). Since 2008, Criterion’s clients, acting under the advice of

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1 Gravette and MacArthur, began investing in Bird Rock’s legacy funds, and as of 2014,

2 $9.5 million in Criterion client funds were invested in the Bird Rock legacy funds.

3 (PSUF 171.) The Bird Rock legacy funds are not at issue in this case.

4 Ausdal entered into private placement agreements with Bird Rock under which

5 Ausdal would broker private placement transactions with Criterion clients in exchange

6 for an annual commission equal to 2% of the assets referred to the fund for as long as

7 investors remained invested in the fund. (PSUF 176, 180.) As with the SREI Fund

8 and AOFIV, Gravette and MacArthur ultimately received 95% of this 2%

9 commission. (PSUF 177, 181.) At the same time that Gravette and MacArthur

10 collected these commissions through Ausdal, Criterion continued to collect its

11 alternative investment fees from its clients invested in Bird Rock funds as a

12 percentage of the then-current value of the Bird Rock investment under management

13 by Criterion. (PSUF 187.)

14 The private placement memoranda for both the Southland Home Mortgage II

15 Fund and the Pacific West Home Mortgage II Fund disclose that Ausdal received

16 “commissions of 2% annually on the purchase price of the [units] sold by Ausdal . . . .

17 Any commissions will be paid by [Bird Rock] and not from the proceeds of the

18 Offering.” (PSUF 193, 196.) Bird Rock also disclosed some form of this information

19 in its Form ADVs for the two Funds. (PSUF 191.)

20 The parties dispute whether Gravette and MacArthur went one step further in

21 the disclosures and informed investors that Gravette and MacArthur as individuals

22 would ultimately receive the commissions Bird Rock paid Ausdal. The SEC asserts

23 that Defendants did not disclose this information in any document they provided to

24 their clients; Defendants assert that the private placement memoranda combined with

25 the related private placement agreements disclose this information. (PSUF 199.)

26 C. The SEC’s Examination

27 From November 1, 2014 to June 30, 2016, the SEC’s Office of Compliance,

28 Inspections, and Examinations (“OCIE”) conducted an examination of Criterion.

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1 (PSUF 222.) In an April 20, 2017 letter to Criterion, the OCIE indicates that

2 Criterion’s Form ADVs “failed to provide adequate disclosures concerning

3 compensation and conflicts of interest” arising from Defendants’ receipt of carried

4 interest, finder’s fee payments, and commissions from Ausdal. (PSUF 224.) The

5 OCIE also found that Criterion “failed to cause Form ADV Pt. 2B disclosures for

6 Messrs. Gravette or MacArthur to be delivered to any clients or prospective clients.”

7 (PSUF 225.)

8 Criterion took remedial action, which included sending a letter to its clients

9 disclosing that most of the alternative investments offered to Criterion clients through

10 Ausdal “were sourced and sponsored by Ausdal and typically paid a one-time sales

11 commission between 5-7%.” (PSUF 229.) Criterion further acknowledged that:

12 [G]iven the potentially considerable amounts of non-advisory

compensation from [the funds], we should have provided more disclosure

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around the potential conflicts of interest in offering these funds to our

14 clients. Although disclosures of non-advisory compensation from

15 commissions or finder’s fees were provided in our Investment

Management Agreement and Firm Brochure, a straight forward clear

16 description would have been in your best interest. Having known in

17 more detail [about] these arrangements would have left our clients better

informed in making a decision to invest. Detailed disclosure always need

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to be our priority.

19

20 (PSUF 231 (second alteration in original) (citing Sew Hoy Decl. Ex. 26 (“Client

21 Letter”), ECF No. 43-5.) Gravette signed the letter and sent it to his Criterion clients

22 (but not MacArthur’s) two weeks before MacArthur left Criterion. (PSUF 232–233.)

23 Criterion took further remedial action by instituting a practice of providing clients

24 with a one-page sheet summarizing, in “plain speech,” the relevant disclosures

25 regarding compensation agreements and conflicts of interest. (PSUF 234–235.)

26 D. Criterion’s Policies and Procedures Manual

27 Separately, but relatedly, throughout most of the time period relevant to this

28 lawsuit, Criterion had in place a Policies and Procedures Manual that it drafted and

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1 instituted in 2008. (PSUF 80, 240.) Criterion updated its policies and procedures,

2 including this in the Manual, only on an “as needed” basis. (PSUF 239.)

3 In 2014, Criterion engaged NRS, a compliance consulting firm, to review

4 Criterion’s compliance practices. (PSUF 241.) NRS observed that Criterion lacked

5 basic compliance infrastructure and proper procedures concerning Gravette’s and

6 MacArthur’s affiliation with Ausdal. (PSUF 242–243.) NRS also noted that Criterion

7 had not updated its Manual since 2008, (PSUF 244), and recommended adding seven

8 sections to the 2008 Manual, including two sections addressing private placements,

9 (PSUF 249). Three years later, in 2017, the OCIE observed that Criterion “ha[d] not

10 revised its Policies and Procedures in over seven years despite changes to its business

11 and applicable regulatory requirements.” (PSUF 252.) Shortly thereafter, Criterion

12 updated its Manual. (PSUF 253.)

13 III. PROCEDURAL BACKGROUND

14 On February 12, 2020, the SEC brought suit against Criterion, Gravette, and

15 MacArthur, setting forth claims for (1) violation of section 206(1) of the Advisers Act,

16 against all Defendants; (2) violation of section 206(2) of the Advisers Act, against all

17 Defendants; (3) violation of section 207 of the Advisers Act, against Criterion and

18 Gravette; (4) violation of section 206(4) of the Advisers Act and Rule 206(4)-7

19 thereunder (the “Compliance Rule”), against Criterion; (5) aiding and abetting

20 violations of the Advisers Act, against Gravette; and (6) aiding and abetting violations

21 of the Advisers Act, against MacArthur. (Compl. ¶¶ 122–151.) On November 1,

22 2021, the SEC moved for partial summary judgment, seeking judgment in its favor on

23 its first, second, and fourth claims. (Notice SEC Mot.) Criterion and Gravette

24 opposed together, (Criterion Opp’n SEC Mot., ECF No. 62), and MacArthur opposed

25 separately, (MacArthur Opp’n SEC Mot., ECF No. 65). The SEC filed a consolidated

26 Reply. (SEC Reply, ECF No. 71.)

27 The same day, Criterion and Gravette, together, moved for partial summary

28 judgment, seeking dismissal of claims one, two, and five, as asserted against them.

11

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1 (Criterion Mot.) MacArthur also moved for partial summary judgment, seeking

2 dismissal of claims one, two, and six, as asserted against him. (MacArthur Mot.) The

3 SEC filed a combined Opposition. (SEC Opp’n Defs.’ Mots., ECF No. 61.) Criterion

4 and Gravette replied together, (Criterion Reply, ECF No. 70), and MacArthur replied

5 separately, (MacArthur Reply, ECF No. 72).

6 IV. EVIDENTIARY OBJECTIONS

7 Criterion and Gravette submit evidentiary objections to certain aspects of the

8 SEC’s Statement of Uncontroverted Facts. (Criterion Objs. PSUF, ECF No. 62-2.)

9 MacArthur also submits evidentiary objections. (MacArthur Objs. PSUF, ECF No.

10 65-2.) Defendants’ objections all are all asserted on the following four bases:

11 relevance, calls for a legal conclusion, lacks foundation, and hearsay.

12 First, as a general rule, most relevance-based evidentiary objections are moot in

13 the context of summary judgment motions. This is because at summary judgment, the

14 question is whether there are genuine disputes of material fact, and accordingly, the

15 relevance inquiry inheres throughout the determination of summary judgment

16 motions. See Burch v. Regents of Univ. of Cal., 433 F. Supp. 2d 1110, 1119 (E.D.

17 Cal. 2006) (“A court can award summary judgment only when there is no genuine

18 dispute of material fact. It cannot rely on irrelevant facts, and thus relevance

19 objections are redundant. Instead of objecting parties should simply argue that the

20 facts are not material.”). Accordingly, Defendants’ relevance-based objections are all

21 OVERRULED.

22 The same is true of objections that an assertion is or calls for a legal conclusion.

23 Id. These objections are duplicative of the summary judgment standard itself and are

24 accordingly OVERRULED. This includes Criterion’s and Gravette’s objections to

25 the testimony of Nakamura (the NRS agent primarily responsible for auditing

26 Criterion) on the basis that it is improper expert opinion testimony.

27 As for Defendants’ “lack of foundation” objections, these are not true

28 evidentiary objections. Defendants argue that certain assertions in the SEC’s

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1 Statement of Uncontroverted Facts do not follow from the cited evidence; Defendants

2 do not argue that a particular piece of evidence is inadmissible because the declarant

3 or deponent lacks personal knowledge of the subject matter. Objections are to be

4 made to individual items of evidence, not to argumentative assertions. (See

5 Scheduling & Case Management Order 8–9, ECF No. 28 (providing an example of a

6 properly submitted evidentiary objection).) Accordingly, Defendants’ “lack of

7 foundation” objections are all OVERRULED.

8 As for Defendants’ hearsay objections, such objections on a motion for

9 summary judgment are very unlikely to move the needle in a significant way unless

10 the challenged evidence is key and no other admissible evidence on the matter is

11 available. See Burch, 433 F. Supp. 2d at 1120 (“[W]hen evidence is not presented in

12 an admissible form in the context of a motion for summary judgment, but it may be

13 presented in an admissible form at trial, a court may still consider that evidence.”).

14 With this in mind, the Court rules on the hearsay objections as follows.

15 To Testimony Exhibit 36. OVERRULED. Testimony Exhibit 36 is an email

16 chain providing evidence Bird Rock paid additional referral fees to Ausdal or

17 Criterion. The SEC will be able to prove that Bird Rock paid referral fees to

18 Defendants in ways other than with the challenged exhibit, such as with testimony.

19 To Testimony Exhibit 19. OVERRULED. Testimony Exhibit 19 is an

20 examination letter containing the OCIE’s determination that Criterion failed to

21 disclose its conflicts of interest. To the extent the letter is offered for the truth of its

22 factual contents, the SEC will be able to prove those facts in ways other than with the

23 letter, such as with testimony. Burch, 433 F. Supp. 2d at 1120. To the extent the

24 letter is not offered for its truth and is offered for some other purpose such as

25 demonstrating notice to Criterion or Criterion’s state of mind, the exhibit is not

26 hearsay. Calmat Co. v. U.S. Dep’t of Labor, 364 F.3d 1117, 1124 (9th Cir. 2004) (“If

27 the significance of an out-of-court statement lies in the fact that the statement was

28 made and not in the truth of the matter asserted, then the statement is not hearsay.”)

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1 To Testimony Exhibits 56 and 58. OVERRULED. Testimony Exhibits 56 and

2 58 are documentation from the auditor, NRS, identifying the gaps in Criterion’s

3 compliance program. To the extent the documentation is offered for the truth of its

4 factual contents, the SEC will be able to prove those facts in other ways, such as with

5 testimony. To the extent it is not offered for its truth and is offered for some other

6 purpose such as demonstrating notice to Criterion or Criterion’s state of mind, the

7 exhibit is not hearsay.

8 V. LEGAL STANDARD

9 A court “shall grant summary judgment if the movant shows that there is no

10 genuine dispute as to any material fact and the movant is entitled to judgment as a

11 matter of law.” Fed. R. Civ. P. 56(a). A disputed fact is “material” where the

12 resolution of that fact “might affect the outcome of the suit under the governing law,”

13 and the dispute is “genuine” where “the evidence is such that a reasonable jury could

14 return a verdict for the nonmoving party.” Anderson v. Liberty Lobby, Inc., 477 U.S.

15 242, 248 (1986). The burden of establishing the absence of a genuine issue of

16 material fact lies with the moving party, and the moving party may meet this burden

17 with arguments or evidence or both. See Celotex Corp. v. Catrett, 477 U.S. 317, 323

18 (1986).

19 Once the moving party satisfies its burden, the nonmoving party cannot simply

20 rest on the pleadings or argue that any disagreement or “metaphysical doubt” about a

21 material issue of fact precludes summary judgment. Matsushita Elec. Indus. Co., Ltd.

22 v. Zenith Radio Corp., 475 U.S. 574, 586 (1986); Cal. Architectural Bldg. Prods., Inc.

23 v. Franciscan Ceramics, Inc., 818 F.2d 1466, 1468 (9th Cir. 1987). The non-moving

24 party must show that there are “genuine factual issues that . . . may reasonably be

25 resolved in favor of either party.” Franciscan Ceramics, 818 F.2d at 1468 (quoting

26 Anderson, 477 U.S. at 250) (emphasis omitted). Provided the moving party has

27 satisfied its burden, the court should grant summary judgment against a party who

28 fails to present evidence establishing an essential element of its claim or defense when

14

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1 that party will ultimately bear the burden of proof on that claim or defense at trial. See

2 Celotex, 477 U.S. at 322.

3 In ruling on summary judgment motions, courts draw all reasonable inferences

4 in the light most favorable to the nonmoving party, refraining from making credibility

5 determinations or weighing conflicting evidence. Scott v. Harris, 550 U.S. 372, 378

6 (2007); Hous. Rts. Ctr. v. Sterling, 404 F. Supp. 2d 1179, 1183 (C.D. Cal. 2004).

7 However, “uncorroborated and self-serving” testimony will not create a genuine issue

8 of material fact. Villiarimo v. Aloha Island Air, Inc., 281 F.3d 1054, 1061 (9th Cir.

9 2002) (quoting Kennedy v. Applause, Inc., 90 F.3d 1477, 1481 (9th Cir. 1996)).

10 “Conclusory” or “speculative” testimony is likewise “insufficient to raise genuine

11 issues of fact and defeat summary judgment.” See Sterling, 404 F. Supp. 2d at 1183.

12 The nonmoving party must provide more than a “scintilla” of contradictory evidence

13 to avoid summary judgment. Anderson, 477 U.S. at 251–52; Addisu v. Fred Meyer,

14 Inc., 198 F.3d 1130, 1134 (9th Cir. 2000).

15 VI. DISCUSSION

16 When parties file cross-motions for summary judgment, the court “evaluate[s]

17 each motion separately, giving the nonmoving party in each instance the benefit of all

18 reasonable inferences.” A.C.L.U. of Nev. v. City of Las Vegas, 466 F.3d 784, 790–91

19 (9th Cir. 2006). In evaluating the motions, “the court must consider each party’s

20 evidence, regardless under which motion the evidence is offered.” Las Vegas Sands,

21 LLC v. Nehme, 632 F.3d 526, 532 (9th Cir. 2011); Fair Hous. Council of Riverside

22 Cnty., Inc. v. Riverside Two, 249 F.3d 1132, 1134 (9th Cir. 2001) (“[T]he court must

23 consider the appropriate evidentiary material identified and submitted in support of

24 both motions, and in opposition to both motions, before ruling on each of them.”). To

25 avoid errors such as the application of the wrong presumption or burden to a party’s

26 showing, the Court analyzes the SEC’s Motion first, followed by the Motions of the

27 Defendants.

28

15

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1 A. The SEC’s Motion

2 The SEC moves for summary judgment in its favor as to liability on its first

3 claim for violation of section 206(1) of the Advisers Act (asserted against all three

4 Defendants), its second claim for violation of section 206(2) of the Advisers Act

5 (asserted against all three Defendants), and its fourth claim for violation of the

6 Compliance Rule (asserted against Criterion only).

7 The Court finds that the SEC establishes Defendants violated section 206(2) of

8 the Advisers Act and that Defendants fail to place that finding in genuine factual

9 dispute. By contrast, genuine factual disputes remain as to whether Defendants

10 violated section 206(1) and whether Criterion violated the Compliance Rule.

11 1. Advisers Act Sections 206(1) and 206(2)

12 Section 206(1) of the Advisers Act prohibits “any investment adviser” from

13 “directly or indirectly employ[ing] any device, scheme, or artifice to defraud any

14 client or prospective client.” 15 U.S.C. § 80b-6(1). To establish a violation of

15 section 206(1), the SEC must prove that (1) Defendants were investment advisers;

16 (2) they utilized the mails or instrumentalities of interstate commerce to employ a

17 device, scheme or artifice; (3) the device, scheme or artifice violated Defendants’

18 fiduciary duty to their clients in that they made false and misleading statements or

19 omissions of material fact to their clients; and (4) Defendants acted with scienter. See

20 S.E.C. v. Merrill Scott & Assocs., Ltd., 505 F. Supp. 2d 1193, 1215 (D. Utah 2007).

21 Section 206(2) of the Advisers Act prohibits “any investment adviser” from

22 “directly or indirectly” “engag[ing] in any transaction, practice, or course of business

23 which operates as a fraud or deceit upon any client or prospective client.” 15 U.S.C.

24 § 80b-6(2). While proving a violation of section 206(1) requires proof of scienter,

25 “[p]roof of simple negligence suffices for a violation of Section 206(2).” Robare

26 Grp., Ltd. v. S.E.C., 922 F.3d 468, 472 (D.C. Cir. 2019); Merrill Scott, 505 F. Supp.

27 2d at 1215 (“The same elements apply for Section 206(2), except that no scienter is

28

16

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1 required. All that need be shown is that the investment adviser failed to disclose a

2 material fact.”).

3 Because the Advisers Act “was directed not only at dishonor, but also conduct

4 that tempts dishonor,” an investment adviser’s “[f]ailure to disclose material facts

5 must be deemed fraud or deceit” within the meaning of section 206. S.E.C. v. Capital

6 Gains Rsch. Bureau, Inc., 375 U.S. 180, 200 (1963). “[P]roof of intent to injure and

7 actual injury to the client” are not required. Id. at 195. Actual and potential conflicts

8 of interests are material facts that section 206 requires investment advisers to disclose.

9 Robare Grp., 922 F.3d at 472 (“[T]he Securities and Exchange Commission has long

10 held that failure by an investment adviser to disclose potential conflicts of interest to

11 its clients constitutes fraud within the meaning of Sections 206(1) and (2).” (cleaned

12 up)).

13 Because the analysis of section 206(2) provides opportunity for extended

14 discussion, the Court begins there.

15 a. SEC’s Second Claim: Violation of Section 206(2)

16 In this case, whether Defendants violated section 206(2), and whether the

17 underlying material facts are in genuine dispute, center on two areas of inquiry. The

18 first is whether Defendants were acting as investment advisers. If they were not, then

19 they did not owe their clients the fiduciary duties the SEC asserts they did. (Compl.

20 ¶¶ 1, 112–113.) If they were, then they owed fiduciary duties, including a duty to

21 disclose conflicts of interest. Vernazza v. S.E.C., 327 F.3d 851, 860 (9th Cir. 2003).

22 The second area of inquiry centers on those conflicts of interest—what they were,

23 whether Defendants needed to disclose them, and whether Defendants did in fact

24 disclose them.

25 The SEC demonstrates it is entitled to judgment as a matter of law in both these

26 areas, and Defendants fail to raise a genuinely disputed issue of fact that might change

27 the result.

28

17

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1 i. Defendants acted as investment advisers in recommending

2 the private placement offerings to their Criterion/Ausdal

3 clients.

4 First, the SEC must demonstrate that Defendants were acting in their capacities

5 as investment advisors. An “investment adviser” is “any person who, for

6 compensation, engages in the business of advising others . . . as to the value of

7 securities or as to the advisability of investing in, purchasing, or selling securities.”

8 15 U.S.C. § 80b-2(a)(11). “Investment advisers typically provide ongoing, regular

9 advice and services in the context of broad investment portfolio management, and are

10 compensated based on the value of assets under management” or other fee-based

11 arrangements. Regulation Best Interest: The Broker-Dealer Standard of Conduct,

12 Exchange Act Release No. 34-86031, 2019 WL 2420297, at *3 (June 5, 2019); see

13 also United States v. Elliott, 62 F.3d 1304, 1311 (11th Cir. 1995), amended, 82 F.3d

14 989 (11th Cir. 1996) (holding defendants were investment advisers when they

15 “received compensation for providing investment advice” and “were also in the

16 business of advising others” (cleaned up)); Abrahamson v. Fleschner, 568 F.2d 862,

17 870 (2d Cir. 1977) (“[P]ersons who managed the funds of others for compensation are

18 ‘investment advisers’ within the meaning of the statute.”). Under federal law,

19 investment advisers owe fiduciary duties toward the clients whose investments they

20 manage. See, e.g., Capital Gains, 375 U.S. at 194.

21 A broker-dealer, by contrast, is “any person engaged in the business of effecting

22 transactions in securities for the account of others.” 15 U.S.C. § 78c(a)(4)(A).

23 “Broker-dealers typically provide transaction-specific recommendations and receive

24 compensation on a transaction-by-transaction basis (such as commissions) . . . .”

25 Exchange Act Release No. 34-86031, 2019 WL 2420297, at *3; cf. S.E.C. v. Hansen,

26 No. 83 Civ. 3692, 1984 WL 2413, at *10 (S.D.N.Y. Apr. 6, 1984) (identifying six

27 relevant factors for determining whether an individual acted as a broker). In contrast

28 to investment advisers, broker-dealers were subject to the less stringent “suitability”

18

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1 standard at the times relevant to this action.6 FINRA Rule 2111(a). Under this

2 standard, broker-dealers must deal fairly with clients and broker transactions in a way

3 that is suitable to those clients’ individual traits and needs, but this duty does not rise

4 to that of a fiduciary. Id. (“A [broker-dealer] must have a reasonable basis to believe

5 that a recommended transaction or investment strategy involving a security is suitable

6 for the customer . . . .”).

7 No party disputes that at the relevant times, Gravette and MacArthur were each

8 dual registrants, meaning that they were registered and regulated by the SEC as

9 investment advisers and simultaneously registered and regulated by FINRA as broker-

10 dealers. (See, e.g., MacArthur SUF 1.) Dual registration in and of itself is permissible

11 and is relatively common, though the practice presents ample opportunity for conflicts

12 of interest to arise. See, e.g., Malouf v. S.E.C., 933 F.3d 1248 (10th Cir. 2019).

13 Defendants argue that the fact that Gravette and MacArthur were also acting as

14 broker-dealers in their capacities as principals of Ausdal somehow means that they

15 were not acting as investment advisers. (Criterion Opp’n SEC Mot 4–13; MacArthur

16 Opp’n SEC Mot. 5–16.) As part of their respective arguments, both sets of

17 Defendants cite the SEC’s three-part test for determining the capacity or capacities in

18 which a dual registrant is acting, Exchange Act Release No. 34-86031, 2019 WL

19 2420297, at *44, and argue that, under this test, they are broker-dealers.

20 Defendants’ arguments miss the broader point. No one argues that Criterion

21 and Gravette were not broker-dealers when they brokered their clients’ private

22 placement transactions and otherwise acted as agents of Ausdal. Therefore, it is not

23 surprising that Defendants are able to marshal a significant amount of evidence and

24 arguments to support their contentions that they qualify as broker-dealers under the

25 SEC guidance. But the question is not whether Gravette and MacArthur ever acted as

26 broker-dealers. The question is whether, regardless of when and to what extent they

27

6 In July 2019, the SEC adopted a “best interest” standard of conduct for broker-dealers when

28 making recommendations related to securities transactions. 17 C.F.R. § 240.15l-1. The parties do

not dispute that the prior “suitability” standard is the one that applies to this action.

19

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1 acted as broker-dealers, they were also acting as investment advisers when they

2 recommended to a Criterion/Ausdal client that the client invest in a particular private

3 placement offering.

4 Based on the statutory definitions of investment adviser and broker-dealer, the

5 answer to this question, as a matter of law, is “yes.” Under those definitions, when

6 Gravette or MacArthur presented a private placement offering to one of their

7 Criterion/Ausdal clients, explained the upside and downside risks of the offering, and

8 discussed whether the private placement would be a wise addition to the investor’s

9 portfolio, Gravette and MacArthur were acting as investment advisers, because they

10 were providing investment advice in the context of broader portfolio management.

11 Exchange Act Release No. 34-86031, 2019 WL 2420297, at *3. Once the investor

12 decided to invest in a private placement and directed Gravette or MacArthur to

13 execute the transaction, Gravette and MacArthur would then step into their roles as

14 agents of Ausdal and broker the transaction in a suitable way on behalf of their client.

15 See id. (observing that broker-dealers make “transaction-specific recommendations”).

16 Simply put, when Gravette and MacArthur discussed or recommended whether a

17 client should invest in a private placement, they were acting as investment advisers;

18 when they discussed or recommended how to execute a private placement transaction

19 (and actually brokered and executed the transaction), they were acting as broker-

20 dealers. Importantly, even after an investor decided to invest in a private placement

21 and Gravette and MacArthur stepped into their roles as broker-dealers, their roles as

22 investment advisors did not cease, and instead continued in full force with respect to

23 Criterion’s management of the private placement investments. Furthermore, after

24 Ausdal brokered the transactions and established the investors’ positions in the private

25 placements, Criterion continued to manage those investments and collect management

26 fees. Thus, even after Ausdal brokered the private placement transactions, Gravette

27 and MacArthur continued in their roles as investment advisors with respect to

28 Criterion’s management of the private placements. The fact that Gravette and

20

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1 MacArthur at times stepped into their roles as broker-dealers did not invalidate their

2 roles as investment advisers when they rendered services on behalf of Criterion.

3 No amount of written or oral representations can change this conclusion.

4 Defendants may have had their investor clients sign agreements stating that, when

5 recommending private placement offerings, Gravette and MacArthur were acting in

6 their capacities as broker-dealers for Ausdal. (MacArthur SUF 16 (Firm Brochure

7 stated that “associated persons” of Criterion may, in their “capacities” as investment

8 adviser and broker-dealer, “recommend securities”).) Gravette and MacArthur may

9 also have conveyed as much to their clients orally. (See, e.g., MacArthur Decl. ¶ 11,

10 ECF No. 52 (“Acting in my capacity as a registered representative of Ausdal, I

11 recommended that certain Criterion clients . . . invest in one or more of the Funds.”).)

12 But these representations do not render Gravette and MacArthur solely broker-dealers

13 (i.e., non-investment advisers) in recommending private placements, for the simple

14 fact that the Advisers Act governs investment advisers by operation of law, and

15 advisers may not sign contracts with clients waiving the clients’ rights under the

16 Advisers Act by simply calling investment advising activity something else.

17 Commission Interpretation Regarding Standard of Conduct of Investment Advisers,

18 Inv. Adv. Act Rel. No. 5248, at 10–11 (June 5, 2019) (noting as “inconsistent” with

19 Adviser’s Act “[a] contract provision purporting to waive the adviser’s federal

20 fiduciary duty generally, such as (i) a statement that the adviser will not act as a

21 fiduciary, (ii) a blanket waiver of all conflicts of interest, or (iii) a waiver of any

22 specific obligation under the Advisers Act”).

23 In support of their argument that they were not acting as investment advisers,

24 Defendants also quote the SEC’s own guidance issued in connection with the 2019

25 Regulation Best Interest. Assuming for the sake of argument that this guidance

26 applies to this case, the guidance in fact supports the SEC’s position, not Defendants’.

27 The guidance provides:

28

21

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We are . . . confirming that Regulation Best Interest does not apply to

1

advice provided by a broker-dealer that is dually registered as an

2 investment adviser (“dual-registrant”) when acting in the capacity of an

3 investment adviser, and that a dual-registrant is an investment adviser

solely with respect to accounts for which a dual-registrant provides

4

advice and receives compensation that subjects it to the Advisers Act.

5

6 SEC Release No. 34-86031, at 34–35.

7 Where a financial professional who is dually registered . . . is making an

account recommendation to a retail customer, whether Regulation Best

8

Interest or the Advisers Act will apply will depend on the capacity in

9 which the financial professional making the recommendation is acting.

10 Id. at 99. This guidance does not say anything remarkable about dual registrants and

11 the law that applies to them. The guidance does not, as Defendants suggest, indicate

12 that a person cannot act as both an investment adviser and a broker-dealer at the same

13 time. It also does not indicate that a person acting as a broker-dealer cannot also act

14 as an investment adviser. The guidance simply iterates that, when a dual registrant is

15 engaged in activities regulated by the Advisers Act, the dual registrant is acting as an

16 investment adviser, and when the dual registrant is engaged in activities regulated by

17 Regulation Best Interest, the dual registrant is acting as a broker-dealer. Nothing

18 about the SEC’s guidance or anything in case law suggests that an individual cannot

19 act in both these capacities at various times within the context of a given client

20 relationship.

21 To summarize the discussion thus far, as a matter of law, when Gravette and

22 MacArthur discussed whether an investor client should invest in a private placement,

23 the advisability of the investment, and the effect of that investment on the client’s

24 overall portfolio, they were acting as investment advisers, and thus owed fiduciary

25 duties to their clients. Vernazza, 327 F.3d at 860. One of those duties is the duty to

26 disclose all actual and potential material conflicts of interest inhering in the private

27 placement offerings, id., discussed next.

28

22

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1 ii. Defendants had conflicts of interest they did not fully

2 disclose.

3 Two main types of conflict of interest arose from Defendants’ business

4 structure and compensation arrangement. The first conflict relates specifically to the

5 SREI Fund and AOFIV and the separate classes of shares T2 created for Criterion

6 investors. Criterion created a conflict of interest by offering less favorable shares to

7 Criterion investors and taking a commission while doing so. This created potential or

8 actual conflict between (1) Gravette and MacArthur’s best interest (directing their

9 investors toward the SREI Fund’s and AOFIV’s Criterion-only shares, where the

10 investments would generate broker commissions) and (2) Criterion investors’ best

11 interest (choosing the investment with the compensation structure most favorable to

12 the investor).

13 A second conflict of a slightly different type arose with respect to all four funds.

14 With all four funds, Ausdal continued to receive commissions from the fund managers

15 (according to various formulas) as long as Criterion investors remained invested in the

16 funds. But those commissions were funneling directly back to Gravette and

17 MacArthur, the same individuals who were responsible for making recommendations

18 to Criterion clients and for managing their investments. This created potential or

19 actual conflict between (1) Gravette and MacArthur’s best interest (keeping clients

20 invested in the funds in order to receive commissions) and (2) Criterion investors’ best

21 interest (ensuring they are invested in funds with terms that are most favorable to

22 them, even if it means exiting one of the funds from which Ausdal was receiving

23 commissions).7

24

25 7 This conflict of interest would have been reduced had, for example, Gravette and MacArthur drawn

a steady salary from Ausdal rather than receiving commission revenue contingent on Criterion’s

26 clients remaining invested and the size of those clients’ investments. Had Gravette and MacArthur

done so, their interest in keeping those clients invested in the private placements would be

27

significantly reduced, because their salaries would not be dependent on whether Criterion clients

28 remained invested in the private placements, and they would be able to advise their clients to exit the

private placements without directly harming their own personal interests. Thus, the specific nature

23

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1 With the conflicts clearly delineated, the Court finds that (1) the SEC submits

2 evidence sufficient to substantiate its claim that Defendants failed to fully disclose

3 these conflicts, and (2) Defendants fail to raise a genuine factual dispute about this

4 conclusion, either by submitting evidence showing that they did sufficiently disclose

5 conflicts, or otherwise.

6 The Advisers Act requires “full and fair disclosure of all material facts.”

7 Capital Gains, 375 U.S. at 194. Both actual and potential conflicts of interest are

8 “indisputabl[y] . . . ‘material’ facts with respect to clients and the Commission.”

9 Vernazza, 327 F.3d at 859 (citing Capital Gains, 375 U.S. at 201). Investment

10 advisers owe a fiduciary duty to disclose all potential conflicts of interest “accurately

11 and completely,” id. at 860, “in a manner that would enable their clients to understand

12 the source and nature of the conflicts,” Robare Grp., 922 F.3d at 477. Vague

13 disclosures about how an adviser “might be deriving additional compensation from

14 their trading activities” are inadequate when the adviser is “actually doing so” and

15 fails to apprise clients of the same. S.E.C. v. Westport Capital Markets LLC, 408 F.

16 Supp. 3d 93, 104 (D. Conn. 2019). “[W]hat is required is a picture not simply of the

17 show window, but of the entire store[;] not simply truth in the statements volunteered,

18 but disclosure.” Capital Gains, 375 U.S. at 201.

19 To determine if Gravette and MacArthur sufficiently disclosed the conflicts of

20 interest, the Court looks first to the written disclosures. The existence and content of

21 the written disclosures is not in factual dispute; the parties generally agree on which

22 documents were available to investors and what the documents stated.

23 The Court begins with the first conflict of interest described above, the one that

24 arose when Criterion recommended investors purchase shares in T2 funds with less

25 favorable compensation structures than what was available to non-Criterion investors.

26 This part of the analysis, at least, is relatively simple. Nothing in any of the

27

28 of the compensation agreement structure connecting the fund manager (T2 or Bird Rock), Ausdal,

Gravette, and MacArthur is material, because it directly affects the severity of the conflict of interest.

24

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1 documents—the Firm Brochure, the Form ADVs, the client agreements, the

2 investment agreements, or the private placement memoranda—discloses specifically

3 that Criterion investors were investing in shares that provided a 60/40 profit split

4 when other non-Criterion investors had access to shares that provided an 80/20 profit

5 split. This is a material fact that is part of the conflict of interest that arose when

6 Criterion and T2 created Criterion-specific shares and offered them to Criterion

7 investors. By failing to disclose this information when it was clearly known to them

8 and clearly material to investors’ decisions, Gravette and MacArthur breached their

9 fiduciary duties to their clients.8 (Client Letter 2–3 (disclosing difference in profit

10 splits); cf. id. at 3 (“Given the potentially considerable amounts of non-advisory

11 compensation from the above-mentioned funds, we should have provided more

12 disclosure around the potential conflicts of interest in offering these funds to our

13 clients.”).)

14 The next conflict of interest is the broader one that arose as a result of Gravette

15 and MacArthur receiving ongoing percentage-based commissions from T2 and Bird

16 Rock for keeping Criterion clients invested in the four funds. Upon careful review of

17 all the written disclosure materials Defendants quoted in their briefs and statements of

18 undisputed facts, the Court makes the following observations.

19  Some written disclosures indicated that Ausdal might, at some point in the

20 future, receive commissions or other fees for brokering transactions on behalf

21 of Criterion clients. (See, e.g., Criterion Statement of Additional

22 Uncontroverted Facts (“Criterion SAUF”) 307, ECF No. 62-1 (“The Fund may

23

24

8 Defendants’ argument that the prohibition on selling away prevented them from mentioning the

25 existence of other classes of shares is a red herring. (See, e.g., Criterion Opp’n SEC Mot. 21.) The

selling away rule prohibits a financial adviser from selling investment products without the

26 authorization of the firm with which he is licensed. Bourdel v. Wells Fargo Advisors, LLC,

No. 2:12-cv-01213-MMD-CWH, 2013 WL 1855745, at *3 n.2 (D. Nev. Apr. 30, 2013). However,

27

Defendants’ breach of fiduciary duty was not in their failure to offer their clients shares with better

28 profit splits; it was in their failure to inform their clients of the existence of those shares. Defendants

could have provided their clients with this information without doing any selling away.

25

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1 engage selling agents to offer and sell the Units. Such selling agents may be

2 paid a sales commission . . . .”).)

3  Some written disclosures indicated that Gravette and MacArthur might, at some

4 point in the future, receive commissions or other fees for brokering transactions

5 on behalf of Criterion clients. (See, e.g., MacArthur SAUF 276 (Firm Brochure

6 disclosed that “[i]n their separate capacity(ies) [as representatives of Ausdal],

7 [associated persons] are able to implement investment recommendations for

8 advisory clients for separate and typical compensation (i.e.,

9 commissions . . .).”).)

10  Some written disclosures indicated that Ausdal would in fact, in connection

11 with a particular investment transaction, receive commissions or other fees for

12 brokering those transactions on behalf of Criterion clients. (See, e.g., Criterion

13 SAUF 311 (“The Fund has engaged Ausdal . . . to offer and sell interests in the

14 Fund. . . . Such selling agents may be paid a sales commission . . . .”).)

15 Conspicuously absent from Defendants’ papers, however, is evidence of the

16 natural fourth bullet point in this progression: any written disclosures indicating that

17 Gravette and MacArthur as individuals, and not merely Ausdal, would in fact receive

18 commissions from the brokering of these private placements, or that the commissions

19 were ultimately calculated as some percentage of the Criterion investors’ brokered

20 investment.

21 That Criterion’s clients understood that Gravette and MacArthur were the

22 principals of Ausdal, or that they were the Ausdal agents through which Ausdal

23 brokered the clients’ private placements, does not complete the puzzle. That Ausdal

24 received commissions, and that Gravette and MacArthur worked for Ausdal, do not

25 together imply that Gravette and MacArthur, as individuals, were in fact receiving

26 commissions on any given transaction (after funneling them through Criterion or

27 otherwise). Similarly, nothing suggests that Gravette and MacArthur told their clients

28 that they were the only principals of Ausdal, or any other specific information from

26

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1 which the clients could reasonably infer that commissions for Ausdal meant

2 commissions for Gravette and MacArthur.

3 Ausdal’s receipt of commission fees created a conflict of interest, and

4 Defendants arguably disclosed this particular conflict. However, that Gravette and

5 MacArthur as individuals ultimately received essentially all Ausdal’s commission fees

6 increased the severity of the conflict of interest, because it more directly tied

7 Gravette’s and MacArthur’s personal incomes to whether their investors remained

8 invested. (See n.7, supra.) This extra layer of conflict was undoubtedly material to

9 investors’ decisions because it increased the risk that Gravette and MacArthur would

10 act in their own best interest rather than that of their clients. The written disclosures

11 fail to demonstrate that Defendants disclosed this conflict with sufficient detail to

12 permit their clients to understand its severity.

13 The next consideration is whether there is any evidence that Gravette or

14 MacArthur made these disclosures orally. Having reviewed, to the best of its ability,

15 the extremely voluminous record of this Motion (no less than three Xerox boxes’

16 worth of courtesy copies delivered to Chambers), the Court finds exactly three pieces

17 of evidence suggesting that Gravette or MacArthur may have made oral disclosures.

18 The first is an assertion in Gravette’s declaration which reads as follows:

19

As part of my initial meeting with new investors, I explained that I was

20 dually registered, meaning that I was both a registered representative for

Ausdal, a broker-dealer, and associated with Criterion, an investment

21

adviser. I explained that my association with Ausdal allowed me to offer

22 private placement investments and offerings under Regulation D of the

Securities Act of 1933. I explained that I would be acting as a registered

23

representative of Ausdal with respect to any recommendations relating to

24 private placement investments. I explained that I received commissions

25 on private placements. I also explained that broker-dealers are regulated

by the SEC and the Financial Industry Regulatory Authority (“FINRA”).

26

I also explained the differences between investment advisers and broker-

27 dealers, generally including that investment advisers typically provide

ongoing advice, exercise discretion, receive fee-based compensation, and

28

are regulated by the SEC, while broker-dealers typically provide

27

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transaction-specific recommendations, do not exercise discretion, receive

1

commissions, and are regulated by both the SEC and FINRA.

2

3 (Mot. Decl. Robert A. Gravette (“Mot. Gravette Decl.”) ¶ 38, ECF No. 53 (emphasis

4 added).) The italicized sentence is key, but it suffers from the same infirmity as the

5 written disclosures. It is a generalized statement that, at some point in the future, there

6 may be a private placement, and that, if there is a private placement, Gravette might

7 receive commissions on it. It does not amount to a clear disclosure that, with respect

8 to some particular private placement transaction, Gravette would receive a broker

9 commission.

10 Given that the manner in which Gravette and MacArthur ultimately benefit

11 from commissions on private placements is key to full disclosure of the conflict, the

12 Court might have expected a more robust description of exactly what Gravette said to

13 his clients regarding commissions on private placements.9 As written, Gravette’s

14 statement could simply mean that Gravette told his clients he received commissions as

15 a Criterion investment adviser when he directed an investor to a private placement.

16 That proposition is unremarkable. Gravette’s declaration does not indicate he clearly

17 disclosed that he would individually receive an ongoing percentage-of-investment

18 commission as a broker of the investment transaction.

19 MacArthur also submitted a declaration in support of his Motion. (Mot.

20 MacArthur Decl., ECF No. 52.) Paragraph 11 of this declaration is functionally

21 similar to paragraph 38 of Gravette’s declaration in that MacArthur states that he

22 explained to new clients (1) his dual capacity, (2) what he might do in each capacity,

23 and (3) the general difference between the two capacities. (Id. ¶ 11.) There is one key

24

25 9 The Court notes that when Criterion and Gravette cited Paragraph 11 of Gravette’s declaration in

their Memorandum of Points and Authorities in support of their Motion, they omitted reference to

26 the italicized language altogether. (Criterion Mot. 11.) Several pages later, they again cite

Gravette’s Paragraph 11 and state that, “[a]s discussed above, Gravette disclosed to investors that he

27

received commissions from the Fund Managers based on their investments in the Funds.” (Id.

28 at 15.) But Criterion and Gravette never discussed this particular matter before that point in the

brief.

28

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1 difference, however: MacArthur’s declaration lacks any suggestion that he told his

2 clients that he would individually receive percentage-of-investment commissions as a

3 result of Ausdal’s brokering activity.

4 The only other pieces of evidence that might remotely suggest that Gravette or

5 MacArthur fully disclosed their compensation from Ausdal are the following

6 statements of Gravette and MacArthur, respectively:

7 Before the time of the investment . . . I explained that the investors’

interest in the Four Funds was excluded [from] Criterion’s standard

8

investment management fee because the Fund Manager compensated me

9 through Ausdal contingent upon the investor first receiving a certain

10 return.

11 (Mot. Gravette Decl. ¶ 41.)

12 Prior to the investment, I explained to each Investor that the Investor’s

interest in the Fund (“the “Interest”) would be considered a non-billable

13

asset – i.e., it would be excluded from the calculation of Criterion’s

14 standard investment management fee – because the Fund Manager would

15 compensate me through Ausdal – my affiliated broker-dealer –

contingent upon the Investor first receiving a certain return.

16

17 (Mot. MacArthur Decl. ¶ 15.) Neither of these statements passes muster. First, both

18 statements are primarily about Gravette and MacArthur explaining Criterion’s fee

19 structure to their clients and why certain investments were subject to a lower fee. The

20 main point is why the fee structure is the way it is; the fact that Gravette and

21 MacArthur would individually receive broker commissions is relegated to a

22 subordinate clause whose purpose is to provide a reason for the main point.

23 MacArthur’s statement is particularly ambiguous and could be read as MacArthur not

24 having communicated any of the “because” clause to his clients at all. If this is the

25 only context in which Gravette and MacArthur mentioned that they would

26 individually receive compensation from Ausdal, then it is no wonder some of their

27 clients were unaware of this fact. (See PSUF 214–216.)

28

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1 More fundamentally, though, the plain language of these declarations still fails

2 to establish that Gravette and MacArthur conveyed to their clients the material details

3 of the conflict of interest. As discussed, the material details are that (1) Gravette and

4 MacArthur, as individuals, were ultimately receiving money from Ausdal’s brokering

5 activity; and (2) the money ultimately came to Gravette and MacArthur as some sort

6 of percentage of Criterion client funds invested in the private placements. Nothing in

7 the record—neither Gravette’s Declaration nor MacArthur’s Declaration nor anything

8 else—indicates that Gravette or MacArthur ever conveyed this second detail to their

9 clients. The word “contingent” in the declarations is no talisman; in that context,

10 “contingent” refers to the share structure that makes the fund manager’s performance

11 allocation initially “contingent” on whether the investment cleared the 6% or 8%

12 hurdle, not that Gravette or MacArthur would obtain funds from Ausdal “contingent”

13 on the investors’ continued investment.

14 Moreover, when parties opposing summary judgment motions submit

15 conclusory, self-serving declarations not supported by anything else in the record,

16 courts may, in appropriate instances, find that the self-serving declaration does not

17 place any fact in genuine dispute. F.T.C. v. Publ’g Clearing House, Inc., 104 F.3d

18 1168, 1171 (9th Cir. 1997) (“A conclusory, self-serving affidavit, lacking detailed

19 facts and any supporting evidence, is insufficient to create a genuine issue of material

20 fact.”) That is the case here. Gravette’s and MacArthur’s self-serving declarations

21 regarding what they told clients about their compensation from Ausdal are terse,

22 patchy, and conclusory, and have no support anywhere else in the thousands of pages

23 of record submitted in connection with these Motions. See Potter v. City of Lacey,

24 517 F. Supp. 3d 1152, 1159 (W.D. Wash. 2021) (“Conclusory, non-specific

25 statements in affidavits are not sufficient, and ‘missing facts’ will not be ‘presumed.’”

26 (quoting Lujan v. Nat’l Wildlife Fed’n, 497 U.S. 871, 888–89 (1990)).) Defendants’

27 declarations amount to no more than a “scintilla” of evidence that Gravette and

28 MacArthur in fact fully disclosed the nature of the conflict of interest to their clients.

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1 Anderson, 477 U.S. at 251–52. For that reason, they do not indicate a genuine dispute

2 regarding Gravette’s and MacArthur’s failure to disclose the conflict.

3 For these reasons, the SEC makes a complete showing10 that Gravette and

4 MacArthur violated section 206(2) by failing to provide their clients with the material

5 details of the conflicts of interest that arose from the Criterion/Ausdal business model

6 and compensation structure.11 Defendants submit no evidence suggesting that this

7 conclusion is in genuine factual dispute. Accordingly, the Court GRANTS summary

8 judgment in the SEC’s favor as to liability on its second claim for violation of

9 section 206(2) of the Advisers Act.

10 b. SEC’s First Claim: Violation of Section 206(1)

11 The Court turns to the SEC’s first claim, brought under section 206(1) of the

12 Advisers Act. In order for the SEC to obtain summary judgment on its section 206(1)

13 claim, it must submit evidence substantiating each element of the claim, and it must

14 further demonstrate in the face of Defendants’ rebuttals that no genuine factual dispute

15 exists as to any element. Celotex, 477 U.S. at 322. If a genuine factual dispute exists

16 as to any single element, then the SEC is not entitled to summary judgment in its

17 favor, no matter how clearly or convincingly it demonstrates the other elements.

18

19

20 10 Neither party, in any motion, opposition, or reply, makes anything beyond a passing mention of

the interstate commerce requirement for Adviser Act violations. The Court assumes that this is

21

because the parties do not dispute that Defendants used the mail, telephone, email, or other

22 electronic communications in the course of their relationships with their investor clients. Indeed, no

other assumption appears reasonable.

23 11 The Court reads no special meaning into the “negligence” requirement for section 206(2)

violations. The cases that articulate this negligence requirement all trace back to Capital Gains

24

Rsch. Bureau, 375 U.S. 180. That opinion is devoid of the word “negligence,” and instead strongly

25 suggests that an adviser’s failure to make “full and frank disclosure” of his or her conflicts of interest

is itself the negligent act that violates section 206(2). Capital Gains, 375 U.S. at 196. This appears

26 axiomatic; a fiduciary’s breach of fiduciary duty is equivalent to a negligent act on the part of the

fiduciary because a negligent fiduciary is simply one who failed to meet the applicable standard of

27

care, which, for a fiduciary, is the fiduciary standard. See U.S. Telesis, Inc. v. Ende, 64 F. Supp. 3d

28 65, 68 (D.D.C. 2014) (“[C]laims for negligence and breach of fiduciary duty are evaluated similarly

because they are governed by the same standard of care.”).

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1 As discussed, the main difference between section 206(1) and section 206(2) is

2 that the former requires a showing of scienter. Robare Grp., 922 F.3d at 472. Here,

3 the issue of scienter remains in genuine factual dispute. In the Ninth Circuit, scienter

4 under the Advisers Act refers to “knowing or reckless conduct.” Vernazza, 327 F.3d

5 at 860 (holding that this is the same standard for scienter under both section 10(b) of

6 the Exchange Act of 1934 and section 17(a)(1) of the Securities Act of 1933). Under

7 this standard, “[s]cienter may be established . . . by showing that the defendants knew

8 their statements were false, or by showing that defendants were reckless as to the truth

9 or falsity of their statements.” Gebhart v. S.E.C., 595 F.3d 1034, 1041 (9th Cir.

10 2010); see also Howard v. Everex Sys., Inc., 228 F.3d 1057, 1064 (9th Cir. 2000)

11 (noting scienter may exist when the actor “had reasonable grounds to believe material

12 facts existed that were misstated or omitted, but nonetheless failed to obtain and

13 disclose such facts although [he] could have done so without extraordinary effort”).

14 “Scienter . . . is a subjective inquiry. It turns on the defendant’s actual state of

15 mind.” Gebhart, 595 F.3d at 1042; see Ernst & Ernst v. Hochfelder, 425 U.S. 185,

16 206 (1976) (“There is no indication that Congress intended anyone to be made liable

17 for such practices unless he acted other than in good faith.”). For this reason,

18 “[g]enerally, scienter should not be resolved by summary judgment.” S.E.C. v. Life

19 Wealth Mgmt., Inc., No. 10-cv-04769-RSWL (MANx), 2012 WL 12919299, at *3–4

20 (C.D. Cal. Nov. 9, 2012) (finding a genuine dispute as to scienter).

21 To establish scienter, the SEC points to Gravette’s deposition, in which

22 Gravette indicates he understood that he needed to disclose certain conflicts of

23 interest. (Gravette Dep. 122:17-123:6.) The SEC also points to MacArthur’s

24 deposition suggesting that MacArthur also understood that there were conflicts of

25 interest, and that MacArthur believed he had disclosed all material details of the

26 conflicts to his clients. (Sew Hoy Decl. Ex. 5 (“MacArthur Dep.”) 163:4-8, ECF

27 No. 42-5.)

28

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1 Based on this evidence, and citing Vernazza, the SEC argues that Defendants’

2 failure to disclose their conflicts of interest accurately and completely constitutes

3 evidence of scienter. Even if it does, though, Defendants’ evidence nevertheless

4 places scienter in genuine dispute. Vernazza was, at the trial court level, a review of

5 the SEC’s determination of scienter after an evidentiary hearing. The holding from

6 Vernazza concerns the evidentiary showing required to support scienter, not the

7 showing required to eliminate genuine disputes as to scienter. 327 F.3d at 859–60.

8 Here, Criterion did make some attempt to inform its clients of the potential for

9 conflicts of interest; the Form ADVs and disclosure statements did not altogether

10 avoid the topic. Since 2014, Criterion’s Form ADVs disclosed that “management and

11 associated persons of [the] firm are separately licensed as registered representatives of

12 Ausdal Financial Partners, Inc., a FINRA member broker-dealer.” (Criterion SAUF

13 305.) The Form ADVs further disclosed that dual licensees such as Gravette and

14 MacArthur were “able to implement investment recommendations for advisory clients

15 for separate and typical compensation (i.e., commissions, 12-b1 fees or other

16 sales-related forms of compensation).” (Id.; MacArthur SAUF 276.) The Form

17 ADVs reiterated that “[w]hen appropriate and suitable, our adviser representatives

18 may recommend certain Alternative Asset investments (i.e. private securities) to

19 [Criterion] client[s] in which the associated person may receive separate and typical

20 compensation (i.e. commissions) when acting in their separate capacities as a

21 registered representative of Ausdal.” (Criterion AMF 303.) The Form ADVs further

22 explained in various ways that, when Ausdal acted as the broker-dealer for private

23 placement transactions of Criterion’s clients, the arrangement “create[d] a conflict of

24 interest between [Criterion] and its clients.” (MacArthur SAUF 276; see also id.

25 (citing another part of the Form ADV providing that the arrangement “presents a

26 conflict of interest to the extent that these individuals recommend that a client invest

27 in a security which results in a commission being paid to the individuals”).)

28

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1 Gravette’s and MacArthur’s declarations further indicate that they made oral

2 disclosures to their investor clients related to the conflicts. (Opp’n Decl. Robert A.

3 Gravette (“Opp’n Gravette Decl.”) ¶ 41, ECF No. 64; Opp’n Decl. Mark A.

4 MacArthur (“Opp’n MacArthur Decl.”) ¶ 11, ECF No. 66.) Thus, Defendants did not

5 altogether fail to disclose conflicts of interest. Instead, they disclosed the conflicts to

6 a certain degree through some combination of oral disclosures, Form ADVs, the

7 Criterion investment adviser contract, and the private placement memoranda, and the

8 record reflects that Defendants believed that their disclosures were legally sufficient.

9 (Opp’n Gravette Decl. ¶ 38 (Gravette’s oral disclosures to clients); Opp’n MacArthur

10 Decl. ¶ 11 (MacArthur’s oral disclosures to clients).)

11 Moreover, the record credibly supports the notion that, as to the SREI Fund and

12 AOFIV, Gravette and MacArthur believed they were giving their clients a better deal

13 by securing for them a preferred return and a 60/40 split while charging reduced

14 investment adviser fees, because their clients would ostensibly receive a better return

15 on their investment if the funds fell short of their hurdles, met their hurdles, or slightly

16 exceeded them. (Opp’n Gravette Decl. ¶¶ 48, 53; Opp’n MacArthur Decl. ¶ 27 (“This

17 contingent commission structure . . . reduced the Investors’ downside risk by

18 eliminating or reducing either a recurring investment advisory fee or an up-front

19 commission, which the Investors would have paid even if the Investments

20 underperformed.”); id. ¶ 30; Client Letter 2 (“[W]e felt this arrangement represented

21 the cheapest way to own this type of asset over the course of time.”).) To determine

22 whether or not Gravette and MacArthur were acting in good faith would require the

23 Court to weigh evidence and make credibility determinations, which it is not

24 permitted to do on summary judgment. See In re Entropin, Inc. Sec. Litig., 487 F.

25 Supp. 2d 1141, 1148 (C.D. Cal. 2007) (noting scienter is a “fact-specific issue[] which

26 should ordinarily be left to the trier of fact” (quoting Kaplan v. Rose, 49 F.3d 1363,

27 1375 (9th Cir. 1994), overruled on other grounds by City of Dearborn Heights Act

28 345 Police & Fire Ret. Sys. v. Align Tech., Inc., 856 F.3d 605 (9th Cir. 2017))).

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1 Although the Court can examine these declarations and determine as a matter of

2 law what details were and were not disclosed (and thereby rule as a matter of law on

3 negligence), this does not resolve the question of scienter, because scienter goes to the

4 state of mind of the actor. Gebhart, 595 F.3d at 1042. The Court cannot conclude

5 that Defendants’ failures to disclose were so egregious, extensive, or pervasive that a

6 finding of scienter is required as a matter of law. Defendants thus demonstrate a

7 genuine factual dispute about whether they engaged in “knowing or reckless conduct”

8 in their failures to fully disclose their conflicts of interest. Vernazza, 327 F.3d at 860.

9 Thus, the SEC is not entitled to summary judgment in its favor on its first claim, and

10 the Court DENIES the SEC’s Motion to this extent.

11 2. SEC’s Fourth Claim: Violation of Compliance Rule

12 The SEC asserts its fourth claim against Criterion for violation of the

13 Compliance Rule. Section 206(4) of the Advisers Act renders it unlawful for

14 investment advisers to “engage in any act, practice, or course of business which is

15 fraudulent, deceptive, or manipulative.” 15 U.S.C. § 80b–6(4). To implement Section

16 206(4), the SEC adopted Rule 206(4)-7, the Compliance Rule, which requires

17 investment advisers to “[a]dopt and implement written policies and procedures

18 reasonably designed to prevent violation[s]” of the Advisers Act, 17 C.F.R.

19 § 275.206(4)–7(a), and to review at least annually the adequacy and effectiveness

20 these policies and procedures, 17 C.F.R. § 275.206(4)-7(b). By way of its fourth

21 claim, the SEC asserts Criterion violated the Compliance Rule by failing to keep its

22 policies and procedures current and appropriately tailored to their business.

23 Generic policies that are not tailored to the specific risks of an adviser’s

24 business do not satisfy the Compliance Rule. See In re Sierra Fin. Adv., LLC,

25 99 S.E.C. 1336, 2010 WL 3725370, at *3 (Sept. 23, 2010) (finding violation of the

26 Compliance Rule when compliance manual “recited general legal requirements . . .

27 but did not contain procedures designed to specifically address [its] business

28 operations and investment practices”). Rather, investment advisers should “identify

35

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1 conflicts and other compliance factors creating risk exposure for the firm and its

2 clients in light of the firm’s particular operations, and then design policies and

3 procedures that address those risks.” Compliance Programs of Inv. Cos. & Inv. Adv.,

4 68 Fed. Reg. 74714, 74716 (Dec. 24, 2003). An adviser’s failure to maintain adequate

5 compliance policies and procedures “constitute[s] a violation of [the Compliance

6 Rule] independent of any other securities law violation.” Id. at 74715. A violation of

7 the Compliance Rule does not require a showing of scienter and may rest on a finding

8 of simple negligence. See, e.g., S.E.C. v. Steadman, 967 F.2d 636, 643 n.5 (D.C. Cir.

9 1992).

10 Although the SEC submits evidence suggesting that Criterion did not update its

11 manual for several years and that the manual was therefore out of date in several

12 respects, this showing does not require the Court to conclude as a matter of law that

13 Criterion was negligent in not updating its manual. Gravette testified that he met

14 yearly with compliance consultants and reviewed the adequacy and effectiveness of

15 Criterion’s written policies and procedures. (Criterion AMF 327–328.) The record

16 does not preclude the possibility that Criterion’s failure to update the manual with

17 material related to private placement offerings was an innocent or otherwise non-

18 culpable omission. Moreover, the fact that other aspects of the manual, such as the

19 organizational chart, were out of date, is not relevant to the analysis, because the

20 Compliance Rule requires written policies and procedures that ensure conflicts and

21 other compliance factors are sufficiently operationalized within a firm; it does not

22 require firms to have handbooks that at all times contain a complete set of up-to-date

23 details about the firm. Finally, the fact that Criterion’s compliance consultant

24 recommended updating its policies and procedures manual concerning private

25 offerings, and that Criterion did not update the manual until 2017, likewise does not

26 require a finding of negligence as a matter of law. It is possible that letting three years

27 go by was negligent; or, it is possible that Criterion was justified (that is, was non-

28 negligent) in taking three years to fully update its manual given that it was under

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1 investigation by the SEC. These factual determinations remain in genuine dispute and

2 must be tried. Accordingly, the SEC is not entitled to summary judgment in its favor

3 on its second claim, and the Court DENIES the SEC’s Motion to this extent.

4 In summary, the Court GRANTS IN PART and DENIES IN PART the

5 SEC’s Motion. The Court grants judgment in favor of the SEC on its second claim

6 against all three Defendants, and the SEC’s Motion is otherwise denied.

7 B. Defendants’ Motions

8 The Court now turns to Defendants’ Motions, which are directed toward the

9 SEC’s first claim for section 206(1) violations, second claim for 206(2) violations,

10 and fifth and sixth claims for aiding and abetting by Gravette and MacArthur,

11 respectively. As a preliminary matter, the Court DENIES Defendants’ Motions as to

12 the SEC’s second claim. The Court grants judgment as a matter of law in favor of the

13 SEC on that claim, so Defendants cannot possibly demonstrate that it is beyond

14 genuine dispute that they have not violated section 206(2).

15 1. Section 206(1)

16 Defendants all move for summary judgment in their favor on the SEC’s first

17 claim for violations of section 206(1) of the Advisers Act. As with the SEC’s Motion,

18 scienter is the issue that defeats both Motions of Defendants. In this context,

19 Defendants bear the initial burden of demonstrating with arguments and evidence that

20 the SEC will not be able to establish scienter. This is a rather high burden; Defendants

21 must establish a lack of a certain subjective state of mind (bad faith) as a matter of

22 law. Gebhart, 595 F.3d at 1042. Even if Defendants do meet this burden on each of

23 their Motions, the SEC successfully demonstrates that the existence of scienter

24 remains in genuine dispute. Gravette and MacArthur were indisputably aware of the

25 details of the compensation structure underpinning their clients’ investment in the four

26 funds. They eventually admitted in their Client Letter that they should have provided

27 their clients with this information. Nothing in the record precludes the possibility that

28 Defendants were aware earlier on that they should have provided this information and

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1 failed to do so anyway. Thus, the Court cannot conclude as a matter of law that

2 Defendants lacked scienter. The Court DENIES Defendants’ Motions as to the first

3 claim.

4 2. Aiding and Abetting Claims

5 Finally, Defendants move for summary judgment on the SEC’s fifth and sixth

6 claims, for aiding and abetting violations of the Advisers Act, asserted against

7 Gravette and MacArthur, respectively. Defendants argue that, because the underlying

8 claims for violation of sections 206(1) and 206(2) of the Advisers Act fail, so too do

9 the aiding and abetting claims. (Criterion Mot. 24–25; MacArthur Mot. 21.) But, as

10 discussed, the SEC demonstrates that, as a matter of law, Defendants each violated

11 section 206(2). That being the case, there is certainly a genuine factual dispute as to

12 whether Gravette or MacArthur aided or abetted the other (or Criterion) in violating

13 section 206(2). Defendants proffer nothing to suggest otherwise. Accordingly, the

14 Court DENIES Defendants’ Motions as to the aiding and abetting claims.

15 Thus, Defendants’ Motions are DENIED in their entireties.

16 VII. STIPULATION TO CONTINUE TRIAL

17 On April 8, 2022, while these Motions were under submission, the parties filed

18 a Stipulation to continue the trial and pre-trial dates. (Stip., ECF No. 80.) The good

19 cause supporting the Stipulation was that the Court had not yet ruled on the instant

20 summary judgment Motions. Now that the Court has ruled on the Motions, the

21 Stipulation is moot and is DENIED as such. The Court will consider continuing the

22 trial if the parties submit with their request a concrete, fact-specific proposal to engage

23 in another round of mediation by a specific date. Unless the parties demonstrate good

24 cause in this way or otherwise, trial will remain on calendar as scheduled.

25 VIII. CONCLUSION

26 For these reasons, the Court GRANTS IN PART and DENIES IN PART the

27 SEC’s Motion. (ECF No. 41.) The SEC is entitled to judgment as a matter of law as

28

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1 || to Defendants’ liability on the second claim for violation of section 206(2) of the

2 || Advisers Act. The SEC’s Motion is otherwise denied.

3 The Court DENIES both Motions of Defendants in their entireties. (ECF

4|| Nos. 50, 51.) The Stipulation to Continue Trial is DENIED AS MOOT. (ECF

5 || No. 80.)

7 IT IS SO ORDERED.

9 April 25, 2022 = we

10 Yj, ae

1]

2 OTIS D. IGHT, I

3 UNITED STATES DISTRICT JUDGE

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